Nigeria's Fuel Subsidy Removal: Policy Options for Reducing its Adverse Effects on the Poor

Fuel subsidy has now been removed in Nigeria, perhaps with no possibility of return. The Nigerian government and several international organizations have for long been demanding its removal, because it constrains billions of dollars’ worth of annual government funds that can be used in more efficient ways. Plus, fuel subsidies are known to benefit the rich (who use a lot more fuel) than the poor, which the subsidy was originally designed to benefit.

No doubt, the removal of fuel subsidies is needed especially at this time when the government is seriously cash-strapped, due to the effects of COVID-19 on oil prices.

However, fuel subsidy removal can adversely impact low-income household: i) Directly --through increased prices of energy goods and services they consume such as kerosene and liquefied petroleum gas (LPG) for lighting and cooking; and ii) Indirectly -- through increased prices of goods and services that use energy in production and distribution such as food and transportation.

Two broad sets of policy options are available for dealing with this adverse impact of fuel subsidy removal on low-income households:

1. Implementing Social Protection Policies: Policies that add to the incomes of poor households in the form of provision of goods, services, employment assistance and cash transfers can help minimize negative impact on the poor.

  • Many countries subsidize goods like food, public transport, kerosene and LPG; or services like healthcare and education --to compensate for fuel subsidy removal and to minimize the channel of impact on poor households. E.g. Mozambique introduced transport vouchers in 2012 to insulate the poor, following fuel subsidy removal. While such policies are simple to implement, they may suffer from the same problems as fuel subsidies (such as poor targeting, high costs, and illegal diversion), and they may have very limited effect on the immediate price rise arising from the removal.

  • Cash assistance is also known to be useful. It can be in the form of “conditional” cash transfers given upon meeting certain criteria such as school attendance, or “unconditional/ basic income grant” delivered to all households. E.g. In 2008, the Ghanaian government established Livelihood Empowerment Against Poverty (LEAP) program to reduce the impacts of fuel subsidy reforms on the poor; paying beneficiaries US$36 every 2 months or more. If well-targeted, cash assistance can be very effective as it gives household the choice of how to spend their income to meet their greatest needs. However, it requires strong governance and administrative capacity to identify eligible households and update the system to deliver the cash benefits without diversion. Also, this can worsen inflation.

2. Implementing Policies to Manage Inflation: The Central Bank together with the government would have a key role to play in keeping inflation in check after the removal of fuel subsidies. Measures for managing inflation after the policy change include:

  • Linking assistance to sudden large price hikes to assist households during the crises and remove the pressure of re-introducing subsidies. However, this requires good design to ensure that government assistance is tied to the appropriate price hikes.

  • Monitoring, enforcement and transparency systems to monitor prices across the country, collect consumer complaints, investigate and prosecute allegations of illegal activities and communicate with consumers. But this is administratively complex and requires a new legislation and strong enforcement to be effective.

Past international experiences show that no single policy solution is perfect for dealing with the impact of fuel subsidy removal on the poor. Rather, a collection of compensation mechanisms is recommended. The best solutions are known to be relatively simple to administer, and build on existing social assistance mechanisms in the country.

For Nigeria, social protection policies are deemed most effective for compensating poor households. The compensation mechanisms should seek to achieve the short-term gains of cushioning the immediate impact of fuel subsidy removal (an even COVID19), while also making significant contribution to the long-term objective of poverty eradication.

The compensation mechanisms recommended by the International Institute for Sustainable Development (IISD) for Nigeria in 2016 included: 1) Transport vouchers; 2) Mass transit schemes; 3) E-Wallet for smallholder farmers; 4) Free school meals for school children; 5)Free health care for the vulnerable; 6) Cash transfer scheme; and 7)Vocational skills development program. The IISD estimated that the proposed 7 programs could be implemented with a budget not exceeding ₦250 billion (equivalent to US$ 1.2 billion then, but US$694.4 million now) at the year of inception of the programs, while the cost should reduce in subsequent years. This cost is less expensive than the cost of funding fuel subsidies annually –for instance this estimate is only 35% of the ₦722 billion spent on fuel subsidy in 2018.

Such compensation mechanisms could be mixed and matched across different states, depending on the needs and capacity of each state including Abuja. Importantly, for these compensation measures to be effective at cushioning the immediate impact of fuel subsidy removal on poor households, systems must be put in place to ensure that they are implemented without political interference, discrimination or other biases.

Photo credit: Notes from Atlanta and NaijaGists


Still Craving ? Explore on IMF and IISD

Article Credit: Precious C. Akanonu (Editorial)

Tags: #Nigeria #FuelSubsidyRemoval #Low-IncomeHouseholds #ThePoor

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